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A Third-and Better-Way for Prescription-Drug Coverage

Health care has emerged as one of the top issues in this year's election, and,
not surprisingly, the rhetoric has reached a fevered pitch. Calls for reform have
focused on adding a prescription-drug benefit to Medicare, an obvious gap in coverage
since drugs are the fastest-growing component of health-care spending. Polls show
a majority of Americans want generous prescription-drug coverage, and politicians,
including Vice President Al Gore and Gov. George W. Bush, are dutifully competing
to add comprehensive benefits.

Lost in the political cacophony is the concern expressed by many voters about
Medicare solvency. The Medicare population is expected to increase by 15 million
to 18 million in the next 20 years, and health-care costs are growing at rates
far exceeding total economic growth. This will put enormous strain on the Medicare
program. What is needed is a drug benefit that fills the gaps in existing coverage
but does not imperil the Medicare trust fund. Such a plan is easily within reach.

First, any reform proposal should recognize that lack of drug coverage is
not a universal problem. More than 60% of Medicare beneficiaries already have
supplemental insurance that covers prescription drugs. Most of this comes from
private sources such as former employers, individually purchased Medigap plans
or Medicare health maintenance organizations. Furthermore, state Medicaid programs,
all of which cover prescription drugs, provide a safety net for those with low
incomes.

So what is the problem? About 40% of Medicare beneficiaries do not have prescription-drug
coverage, and some supplemental policies may be inadequate. As a consequence,
7.7 million Medicare beneficiaries will spend, on average, more than $1,000
out-of-pocket next year for prescription drugs alone. With drug prices rising
13% annually and many new drug therapies on their way to market, this burden
will increase rapidly over the next 10 years. Most of these drug expenses go
toward treating chronic illness, leaving some elderly people facing catastrophic
drug costs.

Both Gore and Bush are proposing to cover prescription drugs in Medicare.
Under the Gore proposal, drug coverage would be added to the existing set of
Medicare benefits. Bush's plan would subsidize the purchase of private drug
coverage, akin to the way one buys Medigap insurance. But before responding
too quickly with comprehensive plans, policymakers would do well to remember
that forecasting Medicare expenses is tricky business.

Still, there is a fiscally prudent solution to the drug-coverage issue. First,
provide a comprehensive drug benefit for people whose incomes are low but too
high for Medicaid. Second, for middle- and upper-income beneficiaries without
supplemental coverage, place a cap on out-of-pocket drug expenditures of $2,000
a year. Third, administer the plan through a private pharmaceutical benefits
manager to reduce costs; aggressive benefits management has been shown to reduce
drug expenditures by 15% or more.

Such a plan would cost $15 billion in 2003. If Congress decided to charge
beneficiaries a premium for this drug coverage, the net costs would be even
less and would ensure that beneficiaries paid part of the costs if the program
got too expensive.

This plan costs a lot less than competing alternatives. The Kaiser Family
Foundation estimates the Gore prescription drug plan would cost $35 billion
in 2003, despite an annual cap on out-of-pocket expenses of $4,000 and a monthly
premium of $25. Why is the Gore plan more expensive if it has a higher cap?
Mainly because it also pays half the costs of drug expenses below $2,000 annually.
By providing generous coverage without any deductible, the Gore plan removes
incentives to economize on drug expenditures. Of course, it does have the politically
appealing feature that beneficiaries see a benefit almost every time they go
to the pharmacy, but this is good politics, not good health policy.

A catastrophic plan also draws upon the best features of Bush's proposal,
without the uncertainties. His plan would create an out-of-pocket spending cap
for all Medicare benefits, not just prescription drugs. This addresses a fundamental
paradox in Medicare: It is supposed to provide insurance, and yet the federal
government places limits on the amount it will pay if a beneficiary incurs extraordinary
expenses. A cap on out-of-pocket expenses transfers this catastrophic risk from
the beneficiary to the entity most able to afford it: the federal government.
Congress should consider extending a catastrophic cap on drug expenses to all
Medicare services, but only after the costs of a new drug benefit become clearer.

The problem with Bush's proposal—in addition to its vagueness—is that it
relies on the private sector to offer a prescription-drug benefit. Such a market
is unlikely to develop. Insurance plans would bear the full risk of the benefit
under his plan, making them reluctant to be among the first to offer a product.
In addition, enrollees would be allowed to switch plans with few constraints.
Presumably, this fosters competition and increases choice. More likely, it would
exacerbate the role of adverse selection, by which enrollees with high drug
expenditures switch to more generous plans, thereby raising premiums and driving
out healthy beneficiaries. The result is very expensive plans with a few very
sick enrollees.

Prescription-drug expenses have been growing rapidly over the past decade,
and the Medicare population is increasing as well. Under such scenarios, any
prescription-drug benefit would become quite costly. Implementing a modest catastrophic
benefit with low-income subsidies would provide valuable insurance to the Medicare
population. It also would provide a fiscally prudent alternative, allowing policymakers
to better gauge future program costs and beneficiary behavior before committing
to more comprehensive coverage. This seems a much wiser course than spending
future budget surpluses that may prove ephemeral.

Dana P. Goldman and Geoffrey F. Joyce are health economists at RAND.

This commentary originally appeared in Los Angeles Times on November 5, 2000.

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